Chp 3. STRATEGIC MANAGEMENT AND INDUSTRY ANALYSIS

Victor Barros, CFA

Equity Research – Masters in Finance

2020/2021

Chp 3. STRATEGIC MANAGEMENT AND

INDUSTRY ANALYSIS

1. Strategic Management

2. Industry Overview

3. Competitive Positioning

4. Example: Airline Industry

OUTLINE

Victor Barros | ISEG (U Lisbon) 2

CONTENT

3

Strategic ManagementSTRATEGIC MANAGEMENT AND INDUSTRY ANALYSIS

1

Victor Barros | ISEG (U Lisbon)

SOURCES OF SUPERIOR PROFITABILITY

CORPORATE VERSUS BUSINESS STRATEGY

©2015 Grant & Jordan, Foundations of Strategy 4

If ROIC < WACC, is the company able to add value?

ROIC = (Net Income – Dividends) ÷ Invested Capital [as book values]

Invested Capital = Equity + Net Debt = Fixed Assets + Intangible Assets + Current Assets – Current Liabilities – Cash

DESCRIBING STRATEGY

©2015 Grant & Jordan, Foundations of Strategy 5

THE BASIC FRAMEWORK: STRATEGY AS A LINK

BETWEEN THE FIRM AND ITS ENVIRONMENT

©2015 Grant & Jordan, Foundations of Strategy 6

Understand if:

▪ the company has resources and capabilities to put in place its strategies;

▪ strategies fit into the industry environment

SOURCES OF COMPETITIVE ADVANTAGE

©2015 Grant & Jordan, Foundations of Strategy 7

UNDERSTANDING THE BUSINESS:

COMPETITIVE ANALYSIS

Cost Leadership

Differentiation

Cost Focus

Differentiation Focus

Low Cost Differentiation

8

Broad

Target

Market

(Industry Wide)

Narrow

Target

(Market Segment)

▪ Companies are increasingly accepting responsibilities

that extend well beyond the immediate interest of

shareholders:

- For ethical reasons

- For reasons of self-interest

- Sustainability (it is in both society’s and the firm’s interests to

sustain the ecosystem)

- Reputation (CSR enhances the firm’s reputation with consumers

and third parties)

- License to operate (firms need the approval and support of the

constituencies on which they depend)

CORPORATE SOCIAL RESPONSIBILITY

©2015 Grant & Jordan, Foundations of Strategy 9

Include

in the

BD

Industry OverviewSTRATEGIC MANAGEMENT AND INDUSTRY ANALYSIS

2

10Victor Barros | ISEG (U Lisbon)

INTRODUCTION

Company analysis is the analysis of an individual company, and it requires

understanding a company’s industry and identifying its peers.

- An industry is a group of companies offering similar products and/or

services, whereas a sector is a group of related industries.

- A principal business activity is a source from which a company derives a

majority of its revenues and/or earnings.

- A peer group is a group of companies that are engaged in similar business

activities, and whose economics and valuation are influence by closely-

related factors.

11

INTRODUCTIONIndustry Analysis should provide a picture of where the industry is going and how the subject company fits in.

▪ What are the prospects for growth?

▪ What are the industry’s dominant economic traits?

▪ What competitive forces are at work in the industry and how strong are they?

▪ Which companies are in the strongest/weakest competitive positions?

▪ What key factors will determine competitive success or failure?

▪ How attractive is the industry in terms of its prospects for above-average profitability?

▪ How large is the industry?

▪ How much M&A activity is occurring?

▪ Is it a regulated industry?

▪ Who are the consumers? Is that base growing?

▪ …

12

Re

leva

nt Q

ue

stio

ns fo

r In

du

str

y A

na

lysis

Victor Barros | ISEG (U Lisbon)

THE PROFITABILITY OF US INDUSTRIES, 2000-2010

SIGNIFICANTLY VARIABILITY PER INDUSTRY

Industry Median ROE

2000-10(%)

Leading companies

Tobacco 33.5 Philip Morris Int., Altria,

Reynolds American

Household and personal

products

27.8 Procter & Gamble,

Kimberly-Clark, Colgate-

Palmolive

Motor vehicles and parts 4.4 GM, Ford, Johnson

Controls

Entertainment 3.9 Time Warner, Walt

Disney, News

Corporation

Airlines -11.3 AMR, UAL, Delta Airlines

Source: Data from Fortune 1000 by industry.

See Grant & Jordan 2e Table 2.1 for a more detailed list of US industries.

©2015 Grant & Jordan, Foundations of Strategy 13

HOW CAN WE ACCOUNT FOR THESE

DIFFERENCES IN INDUSTRY PROFITABILITY?

▪ Is it all down to luck?

▪ Some industries are in decline, others are growing fast?

▪ The basic premise that underlies industry analysis is that

the level of industry profitability is neither random nor

entirely the result of industry-specific influences, it is

determined by the industry’s underlying economic

characteristics

INDUSTRY STRUCTURE

©2015 Grant & Jordan, Foundations of Strategy 14

STEPS FOR INDUSTRY ANALYSISTypical steps in industry analysis (Porter, 2008):

Define the relevant industry:

▪ What products are in it? Which ones are part of another distinct industry?

▪ What is the geographic scope of competition?

Identify the participants and segment them into groups, if appropriate:

Who are the

▪ buyers?

▪ suppliers?

▪ competitors?

▪ substitutes?

▪ potential entrants?

Assess the underlying drivers of each competitive force to determine

which forces are strong and which are weak and why.

15Victor Barros | ISEG (U Lisbon)

STEPS FOR INDUSTRY ANALYSISTypical steps in industry analysis (Porter, 2008):

Determine overall industry structure, and test the analysis for consistency:

▪ Why is the level of profitability what it is?

▪ Which are the controlling forces for profitability?

▪ Is the industry analysis consistent with actual long-run profitability?

▪ Are more-profitable players better positioned in the relation to the five

forces?

Analyze recent and likely future changes in each force, both positive and

negative.

Identify aspects of industry structure that might be influenced by

competitors, by new entrants, or by the company.

16Victor Barros | ISEG (U Lisbon)

APPROACHES TO IDENTIFYING SIMILAR

COMPANIES

• Similar products and/or services

• Industry and sector classification

• A company’s principal business activity

Products and/or services supplied

• Cyclical companies have profits correlated with the overall economy

• Noncyclical companies’ performance is independent of the economy

Business-cycle sensitivities

• Groups based on correlations of security returns

• Based on historical returns, but relationship may not continue in the future

• May associate firms based on chance or may exclude important relationships

Statistical similarities

17

IDENTIFYING PEER GROUPS

18

Examine classification systems

Review subject company’s annual report

Review company’s competitors’ annual reports

Confirm comparability with potential peers

INDUSTRY OVERVIEW & COMPETITIVE

POSITIONING: STRUCTURE

19Victor Barros | ISEG (U Lisbon)

Bottom-up approach

Aggregates individual company forecasts to industry

forecasts

…may be aggregated to

macroeconomic forecasts

Top-downapproach

Starts with macroeco-

nomicforecasts

Moves to industry

forecasts

…and then to individual

company and asset

forecasts

An

aly

sis

of

P

ric

ing

An

aly

sis

of S

up

ply

of P

rod

ucts

/

Se

rvic

es

An

aly

sis

of

De

ma

nd

for

Pro

du

cts

/ S

erv

ice

s

Ind

ustr

y

Ch

ara

cte

ristics

Corp

ora

te

Pro

file

INDUSTRY OVERVIEW & COMPETITIVE

POSITIONING: STRUCTURE

20Victor Barros | ISEG (U Lisbon)

Business

Description

Industry Overview & Competitive Positioning

INDUSTRY OVERVIEW & COMPETITIVE

POSITIONING: STRUCTURE

21

Industry Characteristics

▪ Stage in its life cycle

▪ Business-cycle sensitivity or economic characteristics

▪ Typical product life cycles in the industry (short and marked by technological

obsolescence or long, such as pharmaceuticals protected by patents)

▪ Brand loyalty, customer switching costs, and intensity of competition

▪ Entry and exit barriers

▪ Industry supplier considerations (concentration of sources, ability to switch

suppliers or enter suppliers’ business)

INDUSTRY OVERVIEW & COMPETITIVE

POSITIONING: STRUCTURE

22

Industry Characteristics

▪ Number of companies in the industry and whether it is, as determined by

market shares, fragmented or concentrated

▪ Opportunity to differentiate product/service and relative product/service price,

cost, and quality advantages/disadvantages

▪ Technology used

▪ Government regulation

▪ State and history of labor relations

▪ Other industry problems/opportunities

INDUSTRY OVERVIEW & COMPETITIVE

POSITIONING: STRUCTURE

23

- Sources (concentration, competition, and substitutes)

- Industry capacity Outlook –short, medium, and long term

- Company's capacity and cost structure

- Import/export considerations

- Sources of demand

- Product differentiation

- Past record, sensitivities, and correlations with social, demographic, economic, and other variables

- Outlook – short, medium, and long term, including new product and business opportunities

Su

pp

lyD

em

an

d

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PEST ANALYSIS

How macro-environmental factors might impact a business

organization:

PoliticalChanges in government economic policy, e.g.

taxation, government spending, monetary

policy

Changes in legal requirements e.g.

employment

law, health and safety legislation, licensing

practices, environmental regulations,

competition policy

Changes in the government ownership e.g. nationalization, privatization, de-regulation

EconomicChanges in the level of economic activity, e.g.

growth rates, rates of unemployment, inflation

Changes in wage rates and income

distributionChanges in exchange rates

SocialChanges in demographics e.g. the size of the

population, the age distribution with the

population

Changing attitudes e.g. work/life balance,

concern for the environment, ethical standards

Changes in social structure e.g. socio-

economic groupings, social mobility

TechnologicalDevelopment of new products and processes

Automation

Developments in information and

communication technologiesDevelopments in the natural sciences

©2015 Grant & Jordan, Foundations of Strategy

THE GE/MCKINSEY PORTFOLIO (NINE-BOX) PLANNING MATRIX

©2015 Grant & Jordan, Foundations of Strategy

Industry Attractiveness

▪ Market growth rate

▪ Market size

▪ Industry profitability

▪ Industry rivarlry

▪ Global opportunities

▪ Macroeconomic factos (PEST)

Business Unit Strenght

▪ Market share

▪ Growth in the market

▪ Brand equity

▪ Ditribution channels access

▪ Production capacity

▪ Profit margins relative to competitors

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Competitive PositioningSTRATEGIC MANAGEMENT AND INDUSTRY ANALYSIS

3

26Victor Barros | ISEG (U Lisbon)

FRAMEWORK FOR INDUSTRY ANALYSIS

Intensity of competition

Demographic influences

Macro-economic influences

Governmental influences

Technological influences

Social influences

27

STRATEGIC ANALYSIS AND

COMPETITIVE POSITIONINGPorter’s “Five Forces”

Framework

28

Macroeconomic

Influences

Technological

Influences

Demographic

Influences

Governmental

Influences

Social

Influences

STRATEGIC ANALYSIS AND

COMPETITIVE POSITIONING

29©2015 Grant & Jordan, Foundations of Strategy

FACTORS AFFECTING PRICING POWER AND

PRICE COMPETITION

• Barriers to entry are obstacles or hurdles that limit or restrict the entry of new

competitors in the market

- These barriers keep or discourage new entrants, hence reducing competition

• Industry concentration is the degree to which some companies may

dominate the industry in terms of market share.

- Generally, the more concentrated an industry, the less competitive it is

• Industry capacity is the maximum amount of a good or service that can be

supplied in a given time period

- The more limited the capacity, the greater the companies’ pricing power

• Market share stability is the degree to which market shares change over time

- The more stable the market shares, the less competitive the industry

30

INDUSTRY LIFE CYCLE

31

Sh

ak

eo

ut

Mature

De

clin

e

Embryonic

Time

Dem

an

d

Slow growth

High prices

Significant

investment

High risk

Rapidly

increasing

demand

Improving

profitability

Low

competition

Falling

prices

Slowing

growth

Intense

competition

Declining

profitability

Little or

no growth

Industry

consolidation

High barriers

to entryNegative

growth

Excess

capacity

High

compensation

APPLYING THE LIFE-CYCLE CONCEPT

Using the life-cycle model

• Newer industries tend to be more competitive than mature industries

• Growth companies tend to reinvest in new products and services, and mature companies tend to focus on internal efficiencies

• Mature companies are generally more focused on extending successful product lines

Limitations to the life-cycle model

• Changes may disrupt the cycle: technological change, regulatory changes, social changes, and demographic shifts.

• Not all companies in an industry have the same performance

32

CHARACTERISTICS OF INDUSTRIES

Major companies

Barriers to entry and success

Level of concentration

Impact of industry capacity

Industry stability

Life cyclePrice

competitionDemographic

influences

Governmentand regulatory

influences

Socialinfluences

Technologicalinfluences

Growth vs.defensive vs.

cyclical

33

34

THE LINKS AMONG RESOURCES, CAPABILITIES

AND COMPETITIVE ADVANTAGE

©2015 Grant & Jordan, Foundations of Strategy

35

IDENTIFYING RESOURCES

©2015 Grant & Jordan, Foundations of Strategy

ELEMENTS OF A COMPANY ANALYSIS

Company profile (overview of the company)

Relevant industry characteristics

Demand for the company’s products and services

Supply of products and services, includes analysis of costs

Company’s pricing environment: degree of price competition

Financial ratio analysis: over time and compared with competitors

36

ANOTHER LOOK TO THE INDUSTRY

STRUCTURE AND COMPETITIVE POSITIONING

37

Industry

Overview &

Competitive

Positioning

(IO&CP)

Victor Barros | ISEG (U Lisbon)

Top-Down Approach

Econom

icO

utlook

Industr

yA

naly

sis

/Outlook

Dem

and &

Supply

Com

petitive

Positio

nin

g

FRAMEWORK FOR AN INDUSTRY ANALYSIS

38

Pinto et al. (2016)

Example: Airline IndustrySTRATEGIC MANAGEMENT AND INDUSTRY ANALYSIS

4

39Victor Barros | ISEG (U Lisbon)

EXAMPLE: AIRLINE INDUSTRY

40Victor Barros | ISEG (U Lisbon)

Luxury Airlines

• Virgin Atlantic

• Qatar Airways

• Emirates

• Singapore Airlines

• Etihad Airways

• …

Hub Airlines

• Lufthansa

• United Airlines

• British Airways

• Swissair

• Air France+KLM

• CopaAirlines

• LOT

• Iberia

• TAP Air Portugal

• …

Low-Cost Carriers

• Ryanair

• EasyJet

• WizzAir

• JetBlue

• Norwegian

• Transavia

• AirAsia

• Germanwings [Eurowings]

• Vueling

• Air Berlin [?]

• …?

Cost Leadership

Differentiation

Cost Focus

Differentiation Focus

Low Cost Differentiation

Broad

Target

Market

(Industry Wide)

Narrow

Target

(Market Segment)

EXAMPLE: AIRLINE INDUSTRY

LCC Luxury

Airlines

Hub

Airlines

Victor Barros | ISEG (U Lisbon) 41

EXAMPLE: AIRLINE INDUSTRY

42Victor Barros | ISEG (U Lisbon)

Drivers of Profitability

Main Costs

FuelLabor Costs

Fees & Charges

Revenues

Passenger

Y

ield

RP

K

(Tra

ffic

)

AS

K

(Capacity)

PLF

(Used C

apacity)

An

cill

ary

Yield = passenger revenue ÷ RPK

(demand) RPK = number of paying passengers × total distance travelled

(supply) ASK = seats available × distance flown

PLF = RPK ÷ ASK

EXAMPLE: AIRLINE INDUSTRY

43Victor Barros | ISEG (U Lisbon)

EXAMPLE: AIRLINE INDUSTRY

44Victor Barros | ISEG (U Lisbon)

Margin of +US$14.7 p/ barrel

EXAMPLE: AIRLINE INDUSTRY

45Victor Barros | ISEG (U Lisbon)

Passenger yield is the average fare paid per kilometer (mile)

EXAMPLE: AIRLINE INDUSTRY

46Victor Barros | ISEG (U Lisbon)

EXAMPLE: AIRLINE INDUSTRY

47Victor Barros | ISEG (U Lisbon)

P

Q

EXAMPLE: AIRLINE INDUSTRY

48Victor Barros | ISEG (U Lisbon)

EXAMPLE: AIRLINE INDUSTRY

49Victor Barros | ISEG (U Lisbon)

Should use

EBITDAR

EXAMPLE: AIRLINE INDUSTRY

50Victor Barros | ISEG (U Lisbon)

EXAMPLE: AIRLINE INDUSTRY

51Victor Barros | ISEG (U Lisbon)

EXAMPLE: AIRLINE INDUSTRY

52Victor Barros | ISEG (U Lisbon)

Use normalized

ratios

EXAMPLE: AIRLINE INDUSTRY

53Victor Barros | ISEG (U Lisbon)

EXAMPLE: AIRLINE INDUSTRY

54Victor Barros | ISEG (U Lisbon)

Low

Low

Moderate

Medium-high

High

55

Industry

Overview &

Competitive

Positioning

(IO&CP)Top-Down Approach

Econom

icO

utlook

Global GDP

European GDP

or Asian

or LATAM, etc

GDP in the countries where the company operates

Oil Prices / Jet fuel

Interest rates

Exchange rates

Industr

yA

naly

sis

/Outlook

World Travel Growth

Ancillary Revenue

Passenger Yield

PLF

Regulations

Trends: M&A

Trends: LCC

Dem

and &

Supply

Demand:

Trends

Purchasing power

RPK

Supply:

Competitors

Industry capacity

ASK

Fuel Cost/ASK

Labor Cost/ASK

Com

petitive

Positio

nin

g

Sources of competitive advantage

Porter’s Five Forces

SWOT Analysis

Quality vs Price matrix

Comparisson of EBITDAR m, ROE / ROIC etc

INDUSTRY OVERVIEW FOR THE AIRLINE

INDUSTRY

Victor Barros | ISEG (U Lisbon)